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Three beaten-down Canadian stocks with comeback potential Add to ...

Yes, fallen stars can rise again. Particularly when their fall takes place on the stock market.

Many companies, once high fliers, tumble out of favour with investors.

Some turn things around, first by exhibiting stronger sales growth, then improving profitability. Their share prices follow, offering significant gains for those who bought in at the bottom.

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To be clear, not all beaten-down shares stage a comeback. But it’s more common than you may think for solid businesses to fall out of grace because of transient problems, then come storming back.

To detect some promising turnaround candidates, we looked for smaller Canadian companies that are trading at a deep discount to their previous highs, but are generating optimism among the analysts who follow them. Each of these three companies has had at least two analysts recently increase revenue estimates for the company’s next fiscal year.

And, yes, the shares have already begun to bounce off their lows. There’s no guarantee the gains will continue, of course. But it seems possible that any or all of these three stocks are in the beginning stages of a sustained comeback.

GLV Inc. (GLV) is an engineering-and-equipment company focusing on the pulp-and-paper and water-treatment industries. The Montreal-based business traded above $15 a share in 2008, not long after it sold off its mining-services division, but saw its shares knocked down by the financial crisis and then, more recently, by cost overruns and unprofitable projects. The fiscal year that closed in March was its fourth money-loser in a row.

It was, however, less of a loss than in the past. The old, unprofitable contracts, many inherited via acquisitions, are coming off the books, replaced by new, profitable ones. Restructuring programs have cut expenses. The result: Profitability is in sight.

Investors have noticed, as the shares, at $3.78, have more than doubled from their 52-week lows, with much of the gain coming in the past two months.

“They lost a lot of credibility on the way down, and the sentiment was very negative,” says analyst Pierre Lacroix of Desjardins Capital Markets. “But with the new orders and seeing the light at the end of the tunnel, the stock has started to recover, and we are on the recovery path.”

Mr. Lacroix has a “buy” rating and recently raised his target price from $3.75 to $4.50, owing in part to GLV blowing through his previous mark in the past several weeks. He also says earnings multiples for water-treatment companies are increasing as investors warm to the sector. He expects earnings per share of 18 cents for the current year.

GLV stock now trades at nearly 20 times analysts’ consensus earnings, according to Standard & Poor’s Capital IQ. That, of course, is if GLV merely hits the expectations, rather than continues to exceed them. “If the stars are aligned, they have the ability to deliver [at least 10 cents of] EPS in a quarter,” Mr. Lacroix says.

Strongco Corp. (SQP) was a $20 stock in the middle of the past decade, when it was a high-yielding income trust. Now, the Mississauga-based firm trades for just over $4.

One reason is a less-than-impressive balance sheet. That’s not its only problem, however. The company sells and rents construction equipment in Canada and a portion of the United States. Its customers include the energy and mining industries, as well as the construction companies that have benefited from Canada’s housing boom. All those groups are facing tougher business climates.

At the same time, Strongco is overstuffed with inventory from the manufacturers it represents (Volvo and Case, particularly) because demand hasn’t matched what it ordered.

Much of the equipment is financed with loans from the manufacturers, so the company has more than $250-million in borrowings on its balance sheet, versus EBITDA, or earnings before interest, taxes, depreciation and amortization, of $19-million over the past 12 months. It's a heady ratio of debt-to-earnings that makes it one of the most-leveraged companies on the TSX.

“The story was on the right path, and they were doing all the right things, until last year when they overordered,” says analyst Jason Zandberg of PI Financial.

Strongco, however, posted a sales increase of 6 per cent in its most recent quarter, and earnings came in well above expectations on lower costs. Mr. Zandberg has a “buy” rating and $5.50 target price, which he recently raised based on what he sees as an improving sales outlook, including in Quebec, where he sees an end to the construction moratorium brought about by a government inquiry into corruption within the sector. His price target is just 7.8 times his estimate of 70 cents per share for 2014.

He gives the company a “speculative” risk rating because of its balance sheet, but notes that borrowings related to equipment financing are a normal part of the business, and he suspects Strongco can manage the load over the next several quarters. Still, “it’s been beaten up so bad, valuations are great [a P/E less than eight times his 2014 estimates], and I think it’s a good time to get into the name.”

Colabor Group Inc. (GCL) is in the food distribution business, typically a low-margin, low-growth affair. From 2006 to 2011, however, the Boucherville, Que.-based enterprise more than tripled its sales through a series of acquisitions, and the shares topped $13 as investors enjoyed a healthy dividend.

Profits and payouts have gone in the wrong direction, however. The company was slow to integrate several acquisitions as it made a CEO transition. At the same time, it faced increased competition in its home province from food giant Sysco. Fuel costs rose. And the company says economic conditions in its markets in Eastern Canada continue to depress demand. The quarterly dividend, once nearly 27 cents, is now 6 cents after two reductions.

So why are the shares, at $4.28, up more than 30 per cent from their 52-week low? Things are no longer as bad as they seemed, and may even improve.

“The stock was overly punished for the circumstances,” says analyst Leon Aghazarian of National Bank Financial. “I found the business was improving, and they were integrating the [acquired companies] going forward, but there was obsessive focus on the dividend.”

After the latest dividend cut, announced last month, shares actually rose. The reduced dividend is a 6-per-cent yield that’s supported by a payout ratio of just 25 per cent of Mr. Aghazarian’s earnings estimates. Now, the company has more “financial flexibility” and continues its “relentless efforts” to improve operations.

“They’re better positioned than they were before, and with this dividend noise out of the way, they’ll be focusing on operations and hopefully delivering on that,” he says.

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